US- CHINA TRADE WAR

Introduction:

In today’s globalised world, export and import play a nonpareil role to determine the economic growth of any country. Not all countries possess the necessary resources to produce goods and services that satiate all the needs of the population. While this is true in most cases and economies, certain countries believe that export and import do more harm than good. This leads to the imposition of contractionary trade policies in the form of trade barriers. Trade barriers are enforced by the government of any country as a fiscal measure and they act a restriction on the international trade of that country. 

Initially, the trade barriers may be imposed on trade with the objective to promote and boost domestic industries as protectionist measure, however, in the long run, such policies lead to higher inflation, reduction in supply of numerous goods and services, fall in the employment levels and finally a diminution in the national income. In addition to thee domestic disadvantages, trade barriers can also give rise to trade wars with the countries that these barriers are imposed on.

Trade wars are usually a natural outcome of trade barriers as a reprisal from the countries that are being restricted to trade with the country imposing these barriers in the first place. These are usually in terms of “Beggar-thy-neighbour” Policies as proposed by Adam Smith, and are heavily influenced by the ideologies of protectionism. Trade wars take form due to the repetition in these policies by all countries involved and ultimately lead to long-term detriment if trade negotiations are not commenced.

One such on going trade war has been instigated between two of world’s most significant economies, United States of America and China. Let us examine what fuelled this trade war, the policy implications, and the global impact of it.

 

US- China Trade War:

Overview

The economic growth of the Chinese economy, since its opening- up has been quite commendable and has unswervingly posed as a threat to US due to export-dominant nature of Chinese economy and the import-led US economy (Moosa, 2011). As a result, it was only subsequent that such extreme trade barriers from the US will besiege China. 

As Donald Trump was elected as President, the already-fragile trade relations between US and China have been constantly deteriorating in lieu of the 25% import tariff imposed by the government on several good. This roughly estimates to about $34 billion. Such a drastic trade barrier was inflicted for mainly 2 reasons. Firstly, USA wants to shrink the trade deficit meandering the economy for long which can possible lead to an economic boom. And secondly, it is being used as the aforementioned “Beggar-Thy-Neighbour” Policy in order to deteriorate the extraordinary economic growth of China by targeting some of the most prominently contributing industries of the Chinese economy. (Zhang, 2018)
In retribution, China consistently raised its import tariffs on a variety of commodities: food and agricultural, steel and aluminium, to an equivalent of 16% on US imports by September of 2018 (Amiti; Redding; Weinstein; 2019). Ever-since the tariffs had been placed by the US government, there have been several retaliation cycles, that ultimately lead to a tariff of $112 billion by US on Chinese imports, and a tariff of $75 billion by China on US imports. In addition to these cyclical retaliations, China filed a complaint against USA for imposing trade barriers at the World Trade Organisation.

Impact on the Economies and the World

The US government imposed the heavy import tariff with the ambition that it will succour domestic industries and reduce the trade deficit. However, the impacts of these impositions have been rather contrary. Chinese imported commodities are an integral part of the consumption items of the country. Due to this heavy reliance of the US consumer market on the Chinese imports, the inflation in the economy can be triggered with strong intensity. This will be due to 3 reasons mainly: increase in consumer prices, increase in production of commodities using Chinese imports and increase in cost of investment for the functioning of businesses (Hale; Hobijn, Nechio, Wilson, 2019). However, empirical evidence shows a reduction in the inflation rates on consumption commodities, as opposed to the prediction (source: World Bank database)

According to the IS-LM framework, when the government puts any fiscal policy changes up in the economy, the IS curve shows a shift in the leftward or the rightward direction. Since a trade tariff is a contractionary fiscal policy, the IS curve will shift leftwards or backwards, as a result there will be a simultaneous reduction in the output (in this case GPD growth rate is being taken into account) and the interest rate. 

According to the data provided by the World Bank, the following graphs have been observed. Fig 1 shows the GDP growth rate from 2009 to 2019, and Fig 2 shows the real interest rate from 2009 to 2019. From the graphs given below, it can be clearly observed that while there has been a drop in the GDP growth rate indicating a fall in the rate of increase on the GDP of USA, there has also been a consistent increase in the interest rates of the country (contrary to the IS-LM Model), since the imposition of the import tariffs.

FIG 1

Source: World Bank Database

 

 

 

FIG 2

Source: World Bank Database

 

 

 

In the Chinese economy, these tariffs may have a negative impact on the growth rate owing to the fact that the China is an export-dominant country, and most of its export has been predominantly directed towards US. However the impact on Chinese production industries producing for domestic trade will not be as intense, since China has spared tariffs on the import of various intermediate commodities (Robinson; Thierfelder, 2019). Owing to the IS-LM Framework, the contractionary fiscal policy should lead to a simultaneous reduction in output (GDP Growth rate is being considered) and the interest rates. However, the empirical evidence shows that while there has been a reduction in the GDP growth rate since the imposition of import tariffs on imports from USA, the real interest rates have still shown a rise since 2018. This is clearly in contrast with what the IS-LM model predicted. But numerous researchers predict that if the trends continue, USA and China, both the economies will continue to suffer.

 

FIG 3

Source: World Bank Database

 

FIG 4

Source: World Bank Database

 

 In the long run, due to the decline in the imports, it can be predicted that there will be a relative reduction in the general welfare of the population of the countries due to alteration in the “supply chain networks, reduction in availability of import varities and the complete pass through of the tariffs into domestic prices of imported goods” (Amiti; Redding; Weinstein; 2019).

Such extreme tariffs are going to take a toll on the economy and it is spot-on to assume that neither of the two economies can afford such drastic measures in order to achieve short term benefits or make political testimonies. But what has been overlooked by many is the impact of the US- China trade war on other countries, considering the overriding effect they’ve had in the past over the global economy. Bilateral trade war between these two The imposition of these trade tariffs will most definitely have an impact world prices, this however, might benefit some countries while mutilate others, depending on the responsiveness to the prices in these economies. The credibility of China and US will come under deep scrutiny as the economies worldwide due to these extreme tariff policies in the future, harming the global economy as a whole as a result of the reverberating effect of the trade war. (Robinson; Thierfelder, 2019).

Policy Measures to Control the Trade War

While the trade war between US and China lasts, both the economies should take up drastic and effective policy measures in order to control and curb the future catastrophes that the trade war can stir up. 

Due to the contractionary fiscal policy, in the future there could be a very detrimental impact on the economy of China, considering the falling value of Renminbi (RMB). Chinese monetary policies, are currently focused towards increasing the interest rates, in order to protect the value RMB, and this can be evidently seen Fig 4. RMB has been consistently depreciating since the onset of the trade war. The Chinese foreign exchange reserve still has scope to be spent, and this can be used to as a measure to keep the RMB value from further depreciation. This sort of a policy measure, where in foreign exchange reserve is used to purchase RMB and stringent capital controls are put in place, has worked out for the Chinese economy before, and can prove to be beneficial this time. 

As a measure for revitalizing the bilateral trade relations, the Chinese and the US government signed an agreement to quit the trade war since it could prove fatal to both the economies in the long run. This initial trade deal anticipates opening Chinese markets to American exporters, and provides protection of the intellectual property of American companies. China has also agreed to curb the tariffs put on the imports from USA. According to this phase one trade agreement, US has agreed to cut back the tariffs imposed on the Chinese imports. 

According to the IS-LM model, if these agreements are actually followed through in the future, the outputs in both the economies will rise due to the expansionary fiscal policy. The IS curve for both the economies will shift rightwards, and the welfare in the economy will be enhanced. However, Donald Trump, in his statement on the phase 2 of the bilateral trade agreement, said that the relations between China and USA have been damaged due to the on going pandemic.

 

Conclusion:

Trade wars, are never a constructive idea. They might seem to indicate the country’s political stance, but they prove to be catastrophic to not just the economies involved, but also the global economy as a whole. While the short-term impacts of the trade barriers may be encouraging, the long-term impacts can be fatal. In the case of US and China, the trade tariffs on imports did not impact the inflation, GDP and the interest rates to a very large extent, but continued existence of these tariffs will harm the economy.

From the dialogue going on between USA and China amidst the Corona Virus pandemic, it is clear that the Trump government is not going to go forth with the bilateral trade agreement. This will have a destructive impact on both the economies. 

If this is the case, US and China will have to formulate advance and highly proficient fiscal and monetary policies in order to protect their economies. 

 

                                                                         References:

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